MARGIN OF SAFETY- (A rude WTF reminder)

(This appears in some editions of Deccan Chronicle today and in some, will appear tomorrow. Stock markets give us a rush of blood at some times and some times suffocate us. Logic and reasons are strange in the market)

If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you’d need. If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay; but if it’s over the Grand Canyon, you may feel you want a little larger margin of safety…

Warren Buffett

Stock markets make us human beings behave in strange ways. When things are quiet and stocks are inexpensive, we do not enter the arena. Once things warm up and there is a lot of noise, including anecdotal evidences of fortunes being made by others, we start looking at it. Finally, we succumb. Either though a SIP route (if we convince ourselves that we cannot manage the risks associated with stock picking) or a brave plunge in to the markets, all by ourselves, with friendly tips from media and experts.


Most of us go through our lives without bothering to understand ‘valuation’. And given that over time, stock prices tend to rise, we attribute our investment performance to our skills and ‘information’ network. And when the performance of what we pick happens to be disastrous, we attribute it to lousy experts.


We all have different interpretations of “Value”. To some, it is price. They look at historical highs/lows and seek their comfort. Some look at P/E multiples and buy it. Some look at P/E relative to growth. Some look at the overall market mood and are happy to look at ‘relative’ P/E multiples. Some are happy to chase what they read or hear that some ‘ace’ investor is buying. Sometimes it is ‘story’ based buying. Like we suddenly get bullish on ‘solar’ power or ‘electric fuel’ or ‘retail’ or ‘banking’ etc. Or we have stories like PSU companies going to be managed better. Of course there may be more theories and strategies. However, unless one spends a lot of time in understanding business and financials, you are leaving your investment to chance and luck.


You should make attempts to improve your odds.  One thing we should understand is that we are buying in to future expectations on a company, stock, or economy. Buying the past is the most common thing that everyone does. Even when choosing a mutual fund to invest, we are happy to go by ‘independent’ ranking that is purely based on past performance.


At each stage, when we buy a stock, we are buying in to ‘prospective’ returns. And that means one has to buy at valuations that give us a level of comfort. Stock prices never move according to our expectations. It rarely gives you the ‘speed’ of price movement that you want. Sometimes, even the direction can go wrong. After all, there are thousands of people out there forming a view on a stock, every moment. When you are buying or selling, you are in effect not just impacted by a price but also by expectations.  The prime assumption that one makes is that sooner or later, price will reflect the quality of a company with respect to its earnings and business.


I would urge all of you to read or re-read the chapter on “margin of safety” in the book “Intelligent Investor” by Benjamin Graham. Essentially, it is buying a business at a price that is lower than what it is worth. Yes, we all think times have changed.


Everyone tells me that I will never be able to buy stocks, given my conservative approach. I will miss out on stocks and be stranded with bank deposits and liquid funds. There is so much money flowing in to the markets that downside is ruled out. Everyone wants to buy Indian stocks. Reforms are happening at rapid pace. We are growing rapidly. Banks are getting cleaned up. Transparency in governance. Aadhaar has helped eliminate so much of waste. Oil prices are low. Inflation is low. And GST will multiply the profitability. Low oil prices across the globe. Fastest growing economy in the world.

I prefer to not change my thinking or rules for valuation. Everything will obey the law of gravity. Excesses happen at both ends. I am happy at one end and unhappy at another. Why should I voluntarily choose unhappiness?


I am not going just by the stock market indices. Given that we have a market with over 450 companies that deliver a ROCE of over 15% on an annualized basis, there are enough companies to invest. However, when I scan each of them under a lens, I do not seem to find a ‘margin of safety’ anywhere. One has to have an exaggerated view of future performance and also pray that nothing will go wrong, in order to make even a 15% annualized return. Yes, there is tremendous volatility and there are huge price swings that will lure us to quick returns. However, given growth, interest rates, inflation and valuation, I will be happy to sit this one out. I will be happy to watch the action around me, keeping an eye on any opportunity that will come when the crowd becomes quiet. Sometimes, it pays to hunt alone.






Dilip Pendse, RIP

To those who did not know him, he was in a financial scam involving Tata Finance.

I first met Dilip in 1984, when he was working in a secretarial function in one of the Tata Companies, perhaps Indian Hotels. He helped me and my friends with a lot of introductions within the group and help us win some business. With Dilip, it was business first. He was fiercely loyal to his employers. I doubt if that loyalty every wavered, till two days ago.

During all the times we knew, he never asked us for anything in return. He was happy to see his friends get business on merit. Yes, probably we got some preference because he pushed, but never did he let us do a second best deal.

I lost active touch with him somewhere in the early nineties. I have followed the stories, with scepticism and grief. Grief because a man who devoted his entire life to one employer, was soon hounded by the same employer.

Dilip takes with him many secrets to the grave. Secrets that would hurt some people, who are possibly relieved at his unfortunate end.  Maybe he will be in a story telling mood when we meet him on the other side. He may have done something wrong and reckless. But I doubt he did it for any personal gains. Those who knew him and his lifestyle, will vouch for that.

Whatever he was, he remains, to me, a good man and a good friend.  It is unfortunate that he ended his life in despair and fear. Surely, the Gods above owe some answers for treating him the way they did.

There may be stories and debates about his alleged wrongs. I am happy to ignore them and say a prayer for his soul. Dilip, RIP.

Save or Invest?

(This appears in today’s Deccan Chronicle. Is there a difference between “Savings” and “Investment”? Maybe yes, maybe no. Drawing a distinction, helps you plan your finances better) Here is a link to the article )

Many readers write in, asking for guidance on investing in to shares. Many want a short list of stocks that can be bought for the ‘long term’ or want some names for investing without any time scale in reference. A smaller number ask for names of mutual funds where one could invest. And of course, there are some who want to share the names of stocks they have invested and want a view on each.

Investing is a very personal choice. And everyone has his own risk appetite as well as knowledge of where they want to invest in to. Some of us know and understand the concept of equity mutual funds, some of us can talk about companies and stocks and some can even talk ratios and analyses.  Each one is bound to take a different path to investing his/her savings. For me, more important than the return, is to understand what I am investing in to. And personally, I will never invest in to a product that I cannot understand. For instance, while I may like to trade in shares, I will not touch the derivatives segment in the markets. I used to like the ancient ‘badla’ system on the BSE, but am extremely uncomfortable with the F&O segment. I do not understand it and hence will not risk any money in it.

All of us will either save or invest, so long as we have money to spare after meeting all our expenses. The object behind savings & investment is to keep aside our money till it is either needed by us for some future spend or we want to leave behind some wealth. We can save and invest during our ‘earning’ years.

My distinction between “savings” and ‘investment” is simple. Savings is that money which I keep aside for some emergency needs or unforeseen needs AND some known obligations that will be due in a period of five to ten years.  “Investment” is that money that is left over after my “Savings”. In other words, unless there is some emergency, I am never going to need that money.  Yes, once my investment grows to a sizeable sum, I may have plans to use some of it. However, this money is invested after providing for all my known cash outflows.

When I am putting away money for ‘savings’ I am conservative and will not risk my capital. I will keep my money in what is commonly known as ‘debt’ instruments (Fixed Deposits, Bonds, Liquid Funds etc). Here I have fixed commitments on anticipated dates. If I put it in stocks or derivatives or anything that is subject to market movements, my commitments could be in jeopardy. As an example, if I have a commitment of, say, Rs. One lakh payable in five years, I will start to put aside around Rs.1500 away each month in to a liquid fund. This will ensure that I have the lakh of rupees around the due date or before it. I cannot put 30K in a share today and calculate that at the end of three years, it will be 3X and so on. It is possible that it could be far higher than 3X or even lower. The company may do well, but the  stock market mood could be wrong. Or some economic factors would have changed and so on.

Thus, anything that is subject to fluctuation (shares, real estate, gold, diamonds etc) that cannot be predicted, cannot be in a basket of ‘savings’. It will be considered as ‘investment in my diary. This group is the one that causes most grief to folks out there. Many use the ‘investment’ option for short term play, including leveraged play and come to grief. When you are buying something with a view to selling at a gain in a short period, you are essentially trading in prices. In a short time frame, the earning power or the value of an underlying asset is not going to change fundamentally. What changes are just expectations. Thus, when you make a ‘trade’ you are expecting that you have boarded the train that still has some way to go. When your trade starts ‘working’ in a liquidity driven bull market, you feel that your investment IQ is high. The level of risk taking increases. Often, without knowing the product.

Thus, understanding risk is an important need. The other important thing is to identify our own wants. How long can we spare the money? What are our known commitments? Sustainability and longevity of our ‘earning’ is also equally important. All these will help you deal with Savings & Investments in an appropriate manner.


ANNUITY- In search of Income after work

(This was written in Moneylife, some time ago. Since the noise of the insurance salesman is never ending, I think you may like to form your views on annuity products.)

Annuity: Dead Investment?

Last week, I bought a retirement policy. All I need to do is keep up the payments for 15 years and my agent can retire
There is a lot of noise about annuities. And I am sure, you will be bombarded with agents and media who try to tell you how this product is great for you. Please understand what the product does and how it works, before you plunge headlong. An annuity is a long-term investment that is issued by an insurance company designed to help protect you from the risk of outliving your income. Through annuitisation, your contributions (what you pay) are converted into periodic repayments to you that can last for life. You could invest a lump-sum or invest over a period of time and start receiving payments immediately or at some later date.
Why should it matter whether we choose an annuity from an insurer or whether we directly invest the money ourselves and keep withdrawing monthly amounts? Here, the insurance company plays on your fear—that if you do it yourself, at some point, the money will get over, if you live too long. Or what you can get as income is not guaranteed forever, something that an annuity does. For example, if we keep a fixed deposit (FD) of Rs1 lakh, we can permanently keep getting an interest of, say, Rs8,000 every year. However, the uncertainty is that bank deposits are for a certain period, say, five or even 10 years. At the end, we will have to renew it at the rate of interest prevailing then. It could be higher than 8% or lower than 8%. So, we have to take a view. Human beings hate uncertainties. How about 6% forever? Or 5%? Insurance companies give you a lower rate on annuities, playing on this uncertainty in your mind. Plus they guarantee that the contracted amount will be paid to you for life.
In an FD, you can keep withdrawing the annual or monthly accruals and protect the principal which can go to your nominee. In an annuity, you generally do not have anything residuary, unless you choose a product that has a return of capital to the nominee on your death. In such cases, the annual payouts are also lowered by nearly 20% compared to an annuity that does not return any money on your death. And annuities are taxed in the hands of the recipients as income.
When we compare the option of no return of capital, there is no reason why we should go and seek an insurance company to pay us a fixed amount as annuity. We can simply keep it in an FD or a liquid mutual fund (MF) scheme and get far better returns. And, after three years, the withdrawals can be tax-efficient too in case of a liquid scheme. So, there is no way I will go and buy an annuity today. I am willing to live with the risk of falling interest rates. In fact, if you are short of your retirement date, you should aggressively put at least half the corpus into a ‘balanced’ MF scheme and half into a liquid scheme. Once you need to withdraw, you could work out a systemic withdrawal plan (SWP). Depending on your corpus, you could plan to just take away a part of the growth. Of course, if your corpus is small, and you are the worrying type, you may not have the luxury of taking the risk and it may actually make sense to buy an insurance annuity with no return of capital. That will ensure that you have some amount coming your way.
The ideal way to build up for your annuity is to keep investing in equities up to a year or two before the actual retirement date. By retirement, I mean the time where you stop receiving income other than investment income. If you must buy an annuity product, buy it a year or two closer to your retirement. Do not start investing in annuity products early in life. That is because you can make your money work better than any insurance company can.
If you have to buy annuities, buy it in doses. Start with the first dose after your earning cycle is over. This is because the older you are, the higher are the annuity payouts, since the expectation is that you are closer to death with each passing year. Thus, the annuity is structured in a way where the older you are, the higher is the payout. Just check out this page:
Notice the annuity payouts given on this page. They keep increasing with age. In other words, the later you buy the product, the higher is the annual payout.
There is enough evidence to show why we must save and why we should start saving early. My simple advice is that, when you start early, put larger amounts into equities. Whether you use the mutual fund route, or the direct equity route, is dependent on your temperament. Of course, I am presuming that each of us would be in a position to plan everything precisely. But, in real life, many do not plan and each person’s situation is different from those of others. If you save and invest well, most probably, you will end up with enough cushion. At the other extreme will be those whose circumstances push them to selling whatever assets they own and be at the mercy of their children.

Do ‘No Return of Principal’ Annuities Make Sense?

In cases where there is NO return of your principal, the annual payouts are less than 8%. It is like keeping a FD in a bank and you forfeit the FD to the bank, when you die. However, let us look at it differently. If you opt to keep a corpus in a mutual fund product like liquid schemes that gives a 5% annual compounded return, you can do a SWP (equal withdrawals each year, to exhaust the principal and accumulated growth over a specific period) which will give returns as under:
20 years—7.92 %pa (per annum) of your invested amount withdrawn in EMI style;
15 years—9.49%pa of your invested amount withdrawn in EMI style;
25 years—6.02%pa of your invested amount withdrawn in EMI style.
The LIC table shows an annuity for life equivalent at 9.35% if you are aged 60, and over 12%pa, if you are aged 70. So, here is a situation where an annuity gives a better pre-tax return. As of now, annuities are fully taxable. Whereas, in SWP of MF schemes, we do pay a very low tax on withdrawals after the third year, if we plan well. Also, if your liquid schemes pay higher, their returns are better than annuities.
Thus, I would not totally write off annuity products. For instance, if I am 70, the annuity is a good product, on the assumption that I will live beyond 80 or so. Of course, if I die in a year, the principal is gone. There is a trade-off on the uncertainty of life. For example, with the same corpus, an MF scheme will not give you 12%; but there is comfort that your heirs will get back the principal that you did not live to enjoy. The deeper you get into financial planning, it gets beyond numbers. A lot has to do with your temperament and comfort. However, temperament and comfort must be taken into account after financial literacy, not before. Financial choices make sense only after you fully understand all the product choices before you.

NPAs- ONE way to treat them

NPA. A very vexatious issue. What is terrible is that loans get written off or there is some Crony Debt Restructuring (CDR) and it is business as usual again. There are companies like Indo Count Industries etc where the banks have made sacrifices and all the upside after the loan waiver has been to the promoters.

My suggestion is that whenever there is a loan waiver, the banks should be issued a mix of Preference Shares and Equity Share Options at par equal in value to the amount sacrificed. The options could have a ten year expiry.  All these options can be pooled in to a separate investment vehicle that is managed by professionals in an SPV that belongs to the GOI. This will ensure that the the banks also get some share in the upside.

The preference shares can have a put option at the end of 3 years or so and banks can get it back. The preference shares should carry a dividend  and there should be a condition that preference dividend will get priority over equity dividend and the rate cannot be lower than the equity dividend. Similarly, if there are any stock splits or bonuses, or any other dilution, the bank must be compensated.

It is tragic to see the promoters laughing their way to riches after looting the public money from banks. As it is the public bear the brunt of farm loan waivers. While one could probably attribute that to socialism, this corporate debt write offs has a rich mix of fraud and corruption.

I know my suggestion will not be liked by the business community, but I am sure that any rational human being would support it.

Now, which side of the coin do the politicians, the PMO, the RBI fall? Are they on the side of the businessmen or are they rational?

Yes when there are genuine business failures, there is no impact. But this scheme would work like a pooled insurance. I recall the old days when the development institutions had a compulsory conversion clause for a part of the loan. This kept institutions like IDBI/IFCI alive for years beyond their practical death


(This appears in today’s Deccan Chronicle-

We generally take it for granted that in good times, we can buy a rupee worth of tomorrow’s products, by paying more than a rupee today. As the noise escalates, so does our imaginary gains.. Then …)


Markets have reached a stage where nothing seems to deter a buying idea. Neither a dubious past, not dubious promoter seem to matter. The momentum in the small and mid cap space is so great, that a mere mention of a stock name on the social media is enough to set fire to its price. Everyone is a hero. And some serious investors too do not mind going along, as there is a big fear of ‘being left out’.


If I am an ultra HNI, with no financial worries, I can speculate on the thinnest of reasons. Losing some part of my money is not material to me. The excitement of always having to make a trade is sufficient compensation.


In this market, most of the ideas or recommendations that are now popping up, have the one or more of the following traits:


  1. Absurd valuations being justified by optimistic expectations;
  2. Poor quality of promoters overlooked and justified on price;
  • Commodity stocks getting valuations like pharmaceuticals used to get;
  1. Forgetting the debt on the balance sheets;



In general, the nature of trades that are being done now, put your capital at risk. You have to be absolutely swift in taking money off the table. In investing, there is something that is called as ‘potential’ rewards.  It generally is an inverse of popular sentiments. In other words, when I am buying at a high valuation in a bull market, my return depends on the same conditions persisting or improving when my stock has to be sold. Should sentiments turn, then price can be dented severely and even the recovery of principal can be a big issue.


Thus, it all boils down to risk management at a personal level. At this juncture in the stock markets, the risk reward is clearly unfavourable. It does not mean that you sell everything and go. Keep high quality in to your investment portfolio and treat the not so high quality as opportunistic trades. Play the market according to what you can afford. Also, remember, in the midcap space, buying is a lot easier than selling. When a small stock trades a couple of hundred shares a day, the price moves up rapidly when a few buyers emerge. On the flip side, when people want to sell, you will see the Lower Circuits in operation for many days.


So, how does one address the issue of investment risk in these uncertain times?


For the mutual fund investors, I would think that this is a good time to be in to Balanced Funds. The automatic cap on the equities will ensure better risk management. It will give you some upside of a raging bull market, while protecting you from a big fall. And I am not even betting on a decline in interest rates. If you are having to invest a large amount, I would urge caution. You may not always be lucky in the midcap stock that you buy. One way to check your risk in a new idea, is to see how the price of a stock has behaved over the last couple of years. If most of the rise has been in the last one year or so, then your potential upside is low. Most of the jump COULD have already happened. Yes, of course, there would be some exceptions, but I would still err on the side of caution.


Fundamentals of investment do not change. Valuations are a function of market moods and momentum. As an investor, I like to buy when things are to my advantage. I have yet to see any market that has run away forever. In the late 1980s, the Japanese stock markets ran away as if there was no tomorrow. The Nikkei (an index of Japanese stocks, like our Sensex) was in shouting distance of 40,000. Just have a look at where it is now. In nearly four decades, the index is nowhere near that peak. Of course, not every stock would have done it. But the odds are that most of the stocks would have followed a similar fate.


People tell me that I am too negative on the markets. I am simply paranoid. I see risk at every corner. I am happy to preserve my capital and put money when I am happy with MY assessment of risk and reward. Remember that if something loses half its value, it would have to double from there, to come to status quo (not to mention time value of money).





Stock Markets- A bull on steroids

(This column appears in today’s edition/s of Deccan Chronicle- The Markets are firm on the surface. But the churn that is happening beneath the surface is often the thing that impacts many investors. )

Opportunities Knock

Company results for the quarter ended March 2017 and the full year 2016-17 are tumbling in. Corporate profits are still very poor. Growth in sales and profits seem to be anemic.  And of course, the analyst population has now started to justify its absurd price targets on FY19 earnings!! When they could not forecast three month trends, they expect us to believe a two year in to the future vision.


I also see that companies have raised record amounts of debt and equity in the first four to five months. Most of the debt has gone to simply replace maturing debt.


If you were one of those investors who kept his wits around you in the last six to twelve months and pursued your hobbies, you might consider shifting your attention back to the markets. No. Do not spend all your monies. But start looking around and keep a list of high quality stocks and their prices handy.


When the weak hands panic, the first things to get hit will be the poor quality stocks that have run up (most of the mid cap stocks would fall in this poor quality). The panic will spread to the better-quality stocks also.


What will also help a long term investor is that in the last one year, all analysts upped their earnings estimates simply to justify higher price targets. This means that there is a slew of earnings disappointments across the spectrum. And in a market that is on steroids, disappointments are punished severely. I can see the punishment meted out to a stock like Cummins India, where the market seems to think that the company has lost its mojo. (disclaimer- I own a few shares). I make a distinction between this kind of price fall and price fall in the pharma company stocks where the issues are ethical in nature. Of course, corporate crimes are forgiven and if we subscribe to that, maybe the stock prices will recover one day or the other and go back to its old glories. On the other hand, the market seems to love small growth in companies like HUL, which seemed to have been forgotten till a couple of months ago. Now investors seem to be willing to go back to proven quality names.


The other thing that I hope will happen is that the large stocks will go in to a listless mode. There will be bouts of disappointment which will bring down prices. All of this makes for a good environment in which to invest.


At the point of investing, I am not bothered about the ‘market returns’. My aim is to beat that handsomely. That I can do with minimum risk only if I can evaluate the ‘prospective’ return on my investment. That is, if a stock normally trades in a range of twenty to forty times earnings, our prospective returns are related to the earnings multiple at which we buy. Here, what can distort our analysis, is one instance of earnings failure. So let us use a combination of P/E and price relative to book value. Using both these, we could probably improve our odds.


Another factor that will be disruptive to corporate earnings and balance sheets will be the introduction of GST. It will create bumps in earnings as companies try to game the apparent rate differences and the procedural complexities. To me, it is another event that could provide price falls in stocks. In adjusting and managing the new environment, large companies will manage transition better than the smaller ones, who will find the compliance costs daunting.


One other thing we will notice now is that transgressions by companies will start getting punished. In a bull market, investors are very forgiving. It is a myth that institutional investors are fussy about governance. There are two kinds of companies-  One set that is known to be unfair and unethical. There is another set that we do not yet know. No company can be presumed to be ethical and fair for ever. Somewhere, the pressure to perform at the stock markets has compromised the way people would behave. So, choosing management quality helps to minimize the damage.


All these are symptoms of a nervous market, looking for excuses to correct prices. Yes, it is also possible that prices may be range bound, for a long time, waiting for earnings to catch up.


Once again, do not invest all your money. Spread it out over the next two years. And augment your cash balances by getting rid of those impulsive purchases you made, if you think the valuations are high. A nervous market also corrects our valuation metrics. Stick to your processes and do not rush in. Opportunities will keep coming. If we want to buy five stocks at a reasonable price, it makes sense to prepare a list of ten. We cannot chase every opportunity and not every one on our list may come in to a buying price range.




GST- Speed-breakers to growth

GST is finally about to see the light of day. As an investor, please understand that GST does not give any sustainable edge to any one company over another. Any small savings that happens, will certainly get eroded gradually. You will, in the days and months to come, be reading about ‘GST winners, GST losers’ etc.


There could be marginal shifts in the burden of tariffs due to the changeover from the existing structure of taxes on goods and services to the GST regime. However, any gains or losses on this account will be nothing more than transitory. Competition will ensure that gains/losses are passed on to consumers. Thus, GST by itself is not going to impact the profitability of any company.


GST may bring two broad things- Immediate chaos because changeover problems. This could last for a year or more. And contrary to what should have been a single body administering GST, we have every State Government and the Central Government enthusiastically participating in this and making compliance extremely complex. Let us hope that corruption is reduced. What the government has NOT done so far, is to take away all ‘discretion’ away from the executive powers with administration. IF they do not do so, then corruption will not come down, but rather increase. Small businesses will have a tough time.


The governments (State and the center) will in all probabilities collect a higher revenue under the GST system, as evasion becomes difficult and people are unable to claim their full set offs.

The big blow that has been slipped in is the huge rise in Service tax rates from fourteen to eighteen percent. Probably, this will ensure that the tax collection of the government shows a sharp rise.


We still have the state governments acts on various products. Many cities will lose out on their Octroi collections. The good thing is that transport of goods would perhaps become cheaper as lower bribes will be paid. However, the bureaucracy seems to have armed itself with the onerous documentation requirements that are so complex, that any assesse will gladly pay a bribe to escape the unknown. The E-way bill will ensure that the time saved by Octroi is subsumed and no real benefit happens to businesses.


As it is, I can see the ‘undecided’ items like Gold & Jewelry falling in to a separate bucket. While logic says that they should be in the five percent or higher bucket, the trade lobby is so strong with the politicians that they will get away with a rate as low as one or two percent. Just think. I would have put these at 28%. These are wasted consumption and simply add to the balance of payments problems.


When GST was conceived, it was supposed to be a single point tax, with no role for the state governments. From my experience, I can tell you that business is not as much bothered by the rate of taxes as much by the corruption and harassment by the state governments. Thus, this GST has been a big letdown. GST is also supposed to be a single rate across products, except perhaps some sin products like liquor, tobacco and gambling. That would have been a great thing. However, with so many slabs, the politicians will each year keep shifting products from one band to the other, for some consideration or the other. So, my view is that corruption is going to be same or higher under GST as compared to the present system.


I also think that the 20 lakh rupee limit for applicability is going to be a gold mine for evasion. Why should any one be exempt from GST? If everyone can have an Aadhaar card, they will be connected enough to pay GST. There are enough stories of road side food stall owners being worth crores and crores and not paying any taxes. And if the consuming public are paying MRP for everything, why should anyone be exempt from GST?


Procedural compliances are going to be engaging everyone for the first couple of years. The government machinery has created another weapon of terror and harassment, with the number of forms to be filed at different intervals, with multiple authorities.


When the government came to power, they promised ‘ease of doing’ business. Unfortunately, it seems to be true only if you are a foreign portfolio investor. For Indian businessmen and service professionals, the processes will be a big negative.

Emotions in investing or How to get lower returns from stocks

(This appeared in the Deccan Chronicle of 14/5 & 15/5 – About waking up too late and then worrying about markets and stocks)



One of the readers of this column asked this question:


“I am a follower of your thoughts on investments, being long term, but when do v start buying when markets start correcting, how long should v wait to buy, i understand experts say don’t catch a falling knife, we do not know when will markets stop, then how to buy?”


This line of thinking presumes that there is a lot of things to buy and once the ‘market’ starts to fall, we can buy. Buying is so easy. One can buy whenever the mood seems favourable. Or when the noise is so high that everyone around us seems to be buying and selling stocks. Everywhere there is talk of IPOs and Warren Buffett. It is as if all it takes to make money is to simply buy some stock and then sell it at a higher price.


When money starts to burn a hole in our pocket and we succumb to the noise, it is probably the path to rags from riches. To buy something in the stock market, we must know what we are going to buy. It is not like going to a restaurant and choosing at random from a menu that is handed over to you. Not all stocks will give us similar returns.


Once we identify a stock that we like, the question is when should one buy it? Ideally we should be buying at a price that can give us good returns. Thus, lower the better. Easy to say. But the stock keeps going higher and higher, you say. Are there any measures that we could use to put our finger and pull the trigger?


It is logical to presume that so long as a company keeps growing, its stock price will keep going higher and higher. In a steady state market, where everyone is perfectly logical and rational, prices will keep moving up steadily, in line with the earnings. So you take a measure of past earnings growth and take a call on whether the growth rate will be sustained or not.  In my last column we talked about using the Balance Sheet check to see if the company is healthy or not. Fortunately, our markets are not rational and hence they are always in a zone of over optimism or pessimism.


So, we do not have to be bothered with the Index per se. Yes, if everyone is negative on the economy and on the stocks, all shares will decline in price. In a normal market or in a bull market, everything goes up. Some go up faster than the others. So, in essence we have to bank on gyrations in the market to ‘time’ our buys or sells. The markets keep getting pushed by institutional investors who believe that money is given to them to ‘invest’ and hence will buy stocks for over ninety percent of the money they collect. However, an individual is under no such compulsion. We can wait for our time.


The precondition for shortlist is good fundamental analysis. Now, we have to buy in such a way that our downside is minimised and upside is maximised. I do not recommend using High/Lows as a tool. Simply because as the earnings grow, the valuation also rises. A good proxy to use is the Price to Earnings (PE) ratio. If we take a long history, for instance, I can see that a stock like Hindustan Unilever has traded between PE ratios of 25 to 50. This is a wide range and offers enough actionable space. Thus I will buy this when the PE is closer to 25 rather than 50. It is possible that the PE may never touch 25 or could even go below. For me, it is just one trendline that I use as a support. Similarly, when choosing a stock to sell, I would pick the one that is closer to its historically high PE. While there is no guarantee that this will predict the tops or bottoms, it gives us a process that eliminates our bias and preferences. We may see a market index swinging between a PE of 15 and 24 or so, but each stock will have its own swing range.


It is useful to remember that there is no perfect tool to measure the ‘fair’ value of a stock. It can be only a range. Precision is simply not possible, since the market is a sum of expectations rather than a precise measure of historical earnings. Thus, by using some yardstick, we are able to ‘time’ our buys and sells, with reference to valuations rather than a mere number.


Having a process, helps us to keep our emotions at bay. Emotions generally work to reduce returns from our investments.





Who wins? The businessman or the Investor?

(A brushed up and improved version appeared in Moneylife ..  Just thought I would share this-  How times have changed and perspectives have changed in the capital markets)



Capital Markets are reformers. As more and more people realize it, the game changes. If I go back to time till the early nineties, the stock markets were very benign. Valuations were very moderate. Interest rates were in their mid to high teens. And given licensing and corruption, company growth rates were modest.

We also had a set of archaic rules where even a promoter could not pay himself a salary that was limited by law.  Our economy had the proverbial “hindu” rate of growth. Agriculture was two thirds of the economy. Services was not an officially recognized sector to make a dent.


This naturally meant that there was a big incentive for a promoter to siphon off money from the company. Stock markets were so archaic that a government babu who worked on a book value formula fixed the MRP of a share. Thus, a good company had no incentive to issue shares. Many companies got listed merely for tax reasons. Shares in a private limited company were subjected to ‘wealth’ tax whereas shares in a listed company were not. So many good companies listed. However, they made sure that application forms were distributed to select target groups. Thus, we see that many promoters had holdings between fifty and ninety percent or more.


This sarakari babu also helped in creating immense wealth when he forced companies like Colgate or Lever to issue shares to Indian public based on their formula. Imagine if you had got a 100 shares of Colgate Palmolive at the issue price of Rs.26 (face value Rs.10/-) in 1978 in an IPO that was like the Sikkim Lottery? In the first two years, you would have got dividends and bonuses that would have made the shares free and by now you would perhaps be owning close to a lakh shares! That is, provided you had serendipity on your sides and did not sell out. Hundreds of similar ‘investors’ will be there, but there will be thousands who sold out too soon. Very few investors actually piled on to the secondary markets and made it big.


Promoter wealth creation had to depend more on siphoning money out of the company rather than by building wealth in to the company. The cruel tax structure plus the wretched state of the capital markets led to this promoter behavior. Greed is dormant in all humans. Capital markets brought this alive.


Then came liberalization. And the abolishment of the MRP system for share issuances led to a new paradigm.  Then in trooped the institutional investors and a spread in knowledge about shares, share prices, research reports etc. A liberalized economy brought in with it a flood of capital that also structurally brought down the interest rates. And the government also freed things like promoter salaries etc.


Now, the promoter started to think. He realized that a rupee of additional EPS meant a few more crores added to his wealth. So, stealing from the company was not as remunerative. Of course, there are many whose DNA cannot change. But then the next generation is as smart as their parents. They also have the advantage of an open economy and enlightenment about the capital markets. They know that it is important to show as much earnings as possible, so that the share prices remain high. And yes, one can play games with shares. Private placements, QIP issuances, non-disclosure of promoter holdings in full etc have opened a world of excitement.


The present generation is clued in on the capital markets. So if you think the DNA has changed, think again. It does not. The gene is the same, but the manifestations are different. The entrepreneur dresses up his business to present a façade of attractiveness.


I now see a breed of young investors falling easy prey to the second-generation entrepreneur. The young investor is brash and their crowd is large enough to create a short term ‘self fulfilling’ prophecies when it comes to share prices of small companies.  Gen-next is sharp. They know the key to riches lies in the capital markets. And they have ready accomplice- Investment bankers hungry for fees, institutional investors with other peoples’ money and brokers who know how to lure investors to stocks, no matter how bad. The stock markets are a magnet that draws every participant in to its folds.


As a fly on the wall, there are a few things that strike me. One is that the entrepreneur is as sharp as he was. No one can mess with him. Investor is more aggressive, but more gullible. The regulator has left the field open. Like the Keystone Cops, they will provide the laughs in the end.


Let me close this out with the story of a commodity-based company from Western India. In the eighties and nineties, the earnings used to stagnate. The promoter did not like paying excise duties so most sales proceeds used to be pocketed. Earnings would always disappoint.  Today, newspapers talk about ‘re-rating of the company. The second generation is in control. They have spared no effort to shore up the earnings. And now they talk management jargons. They are now considered as a ‘retail’ brand. Over the decades, public awareness of the brand has been high. But now, the analysts and fund managers are becoming aware of this brand. This is because the investors and analysts have never been to a market to shop for their household. So they believe in the ‘brand’ getting more reach because of advertising campaigns etc. The analysts, if they go beyond their topline and bottom line growth, will find out the true growth story.  However, they are now busy planning their investment in a QIP. Once the QIP happens, the cash will go out of the company and then the stock would perhaps become a ‘bargain’.


Information age? You decide for yourself. Yes you get a slew of information. But that one piece of right information will not come your way. You have to go dig for it. In this battle between the entrepreneur and the Investor, there can be only one winner. Look at the Forbes List. Are there more investors or are there more businessmen whose wealth has been given to them by the capital markets? Choose carefully. Do you want to be an entrepreneur or an investor?


To be an investor, you need money to seed your ideas. On the other hand, if you have an idea, you can seed it with venture capital money and then use the capital markets to create your wealth. And you can exit before anyone finds out whether your business is a winner or a loser.  Ideas for business create wealth of a magnitude far greater than wealth that may be generated by investment ideas.